No relief yet for emerging currencies against dollar

LONDON (Reuters) - Emerging currencies are suffering their sixth straight week of losses against the resurgent dollar but options markets appear to indicate there is going to be no relief for some of them in the short-term.

FILE PHOTO: Bank notes of different currencies, including Euro, U.S. Dollar, Turkish Lira or Brazilian Reais, are photographed in Frankfurt, Germany, in this illustration picture taken May 7, 2017. Picture taken May 7, 2017. REUTERS/Kai Pfaffenbach/Illustration

Turkey and Argentina are squarely at the centre of the rout, with the latter now seeking assistance from the International Monetary Fund. Turkish President Tayyip Erdogan on Wednesday convened an emergency meeting with economic advisors to discuss the battered lira.

Investors picking through the debris are trying to predict where emerging currencies will be heading next. Below are three charts showing the possible pressure points:

1/ TURN UP THE VOL

One-month implied volatility, a gauge of expected swings in a currency, has crept up across many key emerging currencies. Worst hit is Turkey where “vol” has surged above 15 — beyond levels hit during the May 2013 sell-off that has come to be known as the taper tantrum.

This effectively predicts a swing of some 15 percent in the lira, which is undermined by a large current account deficit, high inflation and overly loose monetary policy.

“The nicest period for emerging markets FX is behind us,” said Andreas Koenig, head of global FX for Amundi Asset Management.

“We see the Goldilocks situation going away and it is a good reason for higher volatility, and higher volatility is always in a bit of a risk-off environment.”

Implied vol has also risen on other vulnerable emerging currencies such as South Africa’s rand, while Indonesia’s implied volatility is at its highest in more than a year.

On most other emerging currencies, however, vol remains lower than during February’s equity shakeout. Some analysts attributed this to a belief among investors that the dollar’s rally could soon run out of steam.

“Other than Turkey, if you look at implied vols in other EMs it’s fairly relaxed. To me it indicates people are sceptical about the potential for much more dollar appreciation,” said Peter Kinsella, a strategist at the Commonwealth Bank of Australia.

2/ UP UP AND AWAY FOR DOLLAR SHORTS?

Emerging currencies indexes scaled peak after peak for much of the first quarter but since mid-April the direction of travel has been south.

The main reason is investors taking off bets on a weaker dollar. These “short” positions had built up to a record high by end-March, according to the U.S. Commodity Futures Trading Commission (CFTC) and are now being unwound.

“A first negative feedback loop has kicked in,” Holger Schmieding at Berenberg wrote in a note to clients.

“As investors shy away from some risks, the more vulnerable emerging markets are feeling the pinch from higher U.S. interest rates and a stronger U.S. dollar.”

3/ REVERSE GEAR

CFTC data shows short-dollar bets still remain sizeable, and are likely to be unwound further. As a result, the bias is still for dollar strength against emerging currencies, options show.

One-month risk reversals, a gauge of demand for options on a currency rising or falling against the dollar, are up sharply for both Turkey’s lira and Indonesia’s rupiah over the past 10 days.

They remain off February levels, however, and reversals on other currencies such as Brazil’s real and the Russian rouble have barely budged.

Amundi’s Koenig sees no evidence yet of a huge exodus from emerging equities or debt, but said investors’ first move usually is to hedge currency exposure. That would lead to a greater bias for dollar buying.

“After collecting EM assets and risks for years, investors are starting to reduce those risks. I would say it has further to go,” Koenig added.